Does inherited IRA's qualify as 'retirement funds' within the meaning of bankruptcy?
When constructing a consumer bankruptcy case, an important step is to determine all of a debtor's legal and equitable interests in property and its fair market value. This is what is known as an equity analysis. Because once your case is filed, a bankruptcy estate is created which includes all your legal and equitable interests in your property. See §541(a)(1) The Bankruptcy Code allows a debtor to exempt its interests and the amounts and categories are very specific and limited in scope.
One such specific exemption category is 'retirement funds' under the Federal bankruptcy exemption §522(b)(3)(C). What if you inherited an Individual Retirement Account (IRA), also known as an 'inherited IRA', and subsequently sought bankruptcy relief. Would you be able to fully exempt that inherited IRA under §522(b)(3)(C)? That question was answered by the Supreme Court in Clark v. Rameker, 573 U.S. _____ (2014).
In Clark v. Rameker, the Court first reviewed the term 'retirement funds' and acknowledged that the Bankruptcy Code omitted a definition of that term, so they gave 'the term 'its ordinary meaning'. Page 4. The Court reasoned that under the ordinary meaning of 'funds'; funds are understood as 'sum(s) of money . . .set aside for a specific purpose', and 'retirement means [w]ithdrawal from one's occupation, business or office'. Page 5. Thus, the Court stated that 'retirement funds' were understood to mean 'sums of money set aside for the day an individual stops working'. page 5
The Court then focused its attention on the traits of an inherited IRA and stated that: (1) Unlike a traditional IRA and Roth IRA, one could 'never invest additional money in an inherited IRA because it is prohibited. (2). Holders of an inherited IRA must withdrawal funds from that account 'within five years after the owners death or take minimum annual distributions every year'. (3) Holders of an inherited IRA can choose, free from penalty, to withdraw the whole amount of the 'account at anytime and for any purpose'. Pages 5-6.
Court reasoned that allowing debtors to protect traditional and Roth IRAs in a bankruptcy by the use of the §522(b)(3)(C) 'ensure[s] that debtors will be able to meet their essential needs during their retirement years', which follows from the premise that 'exemptions serve the important purpose of protecting the debtor's essential needs'. Page 7.
By contrast, the Court stated that an inherited IRA, if allowed to be exempted by a debtor from a bankruptcy estate would be free to use the entire balance on such things as for example, a 'vacation home or sports car immediately after [the] bankruptcy proceeding are complete[d]'. Page 7. Thus, the Court declined to expand the 'retirement funds provision' to include inherited IRAs.
I started off this blog by stating the importance of determining whether debtor assets are fully exempted under particular exemption categories, otherwise you could have an asset not fully exempted, or an exemption selection disallowed. An 'equity analysis' of all a debtor's legal and equitable interests in their property guides an experienced consumer bankruptcy attorney on advising a client whether to file a chapter 13 bankruptcy case over a chapter 7 case filing for example. Thus, allowing the debtor the ability to preserve an asset by paying back to the creditors over a chapter 13 plan term length those amounts that cannot be exempted.